Europe 2021 and the end of fiscal prudence

25.7.2021

Europe 2021 and the end of fiscal prudence End-of-term essay. Learning module: „European Integration“, (SoSe 2021) Lecturer: Dr. Thilo Zimmermann

Thomas N. Schneider Mat. Nr. 7366328 Email: tschne29@smail.uni-koeln.de

UNIVERSITY OF COLOGNE, STUDIUM INTEGRALE

In memoriam: David Mitrany (1.1.1888 - 25.7.1975) * When I get older, losing my hair, many years from now, will you still be sending me a valentine, birthday greetings, bottle of wine?1 *

The “Treaty of Rome” (officially: “The Treaty establishing the European Economic Community”) is 64 years old this year.

The decision to establish the Bundesbank was taken on 26.7.1957.

1

The Beatles: “When I’m Sixty-Four”, song lyrics, 1st verse © 1967 Northern Songs.

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Introduction Compared to other key institutions of Europe, say, the Parliament, the Commission, the Council, or the Court of Justice, the European Central Bank (ECB) is an institution that may be less familiar to most citizens. This is no surprise: The inane workings of national banks – which, like so many other European institutions, continue to exist in the shadows of their new European umbrella – with exclusive staff nomination processes, closed-door decision-making and obstruse fiscal instruments have always been a mystery to most people. Bankers do not seek the limelight, and least so central bankers. Nonetheless, with the establishment of the single currency, the euro, on 1st Jan 2002, as the only legal form of cash tender in now 19 of the European Union’s (EU) 27 member states, the ECB is perhaps the prime and only example of a European institution where power has passed from the national to the trans-national level.

More than any other singular step, the abolition of national currencies in favour of the single common currency should have brought to fruition Mitrany’s vision of “a genuine rationalisation of European production – with the abandonment of artificially protected industries, the suppression of tariffs, with the pooling of materials, of knowledge and of credit – [might] [to] lower costs of production and enhance the purchasing power of the populations concerned.”2 It is perhaps unsurprising that the ECB headquarters should be in Frankfurt, de-facto cradle of continental European banking since Germany’s unification and industrialisation in the 19th century, and seat of the Bundesbank since 1957. Despite geographical continuity for Germany, this article argues that the move in the locus of power from a national to a centralized supranational European institution is structurally impacting German national government fiscal responsibility. The issue has moved into sharp focus as German state debt is rising at its fastest historical rate ever, while mid-term balanced budget accounting and prudent state economic policy seem to have gone with the wind. What are the root causes for this behavioural change in the minds of the political elite in what remains Europe’s powerhouse economy, and what are the consequences for the EU as a whole?

In a second part of the essay, it will be argued that the fiscal challenges of the Covid-19 pandemic are different from a sovereign debt crisis and confused by the current ECB board with ideological and political agendas – such as the “greening of society at all costs by stimulating economic growth” - at Europe’s and the world’s peril. The current ECB response overrates the transitory nature of Covid-19 and overlooks real and important inflationary signs.

An institutional shift Undoubtedly, there has been an institutional shift in the interactional dynamics with national government agencies when the ECB became the supra-national - not least in terms of the nationality of its staff - central bank for Europe in 1998. The journey began with the European Council decision of 1988 and the Maastricht Treaty, passing through three stages of European monetary union (EMU). The new relationship can perhaps be summarized as follows: Whereas before, national banks faced the same local economic situational challenges and were steeped in the same economic traditions as national government, with introduction of the euro, a central ECB (deliberate alliteration) is “remotely” interacting with 27 national governments.

2

MITRANY, David: “Pan-Europa – a hope or a danger”, The Political Quarterly, vol. 1, no. 4 (Oct 1930), p. 462.

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Superficially and initially, the ECB would appear to have inherited the successful tenants of the widely admired Bundesbank, often credited with the post-war “German economic miracle”.

Foremost are political independence and the (exclusive) mandate to maintain price stability. As Otmar Issing, financial strategist and former ECB Directorate Member argued insistently in his 2005 speech “One size fits all!”3: price stability is the single monetary policy mantra that must be enforced across the currency union as a whole. In setting interest rates, the ECB must not be distracted by local imbalances, be they wage and price development, differences in real interest rates, employment level, or social costs.

In today`s heated debate about taking urgent action on climate change, he might as well have added energy transition (“Energiewende”) and digital transformation (“Digitalisierung”). All these “distractors” fall in the realm of politics and are the responsibility of politicians, not the ECB, whose sole remit is to maintain fiscal discipline even if this exerts pressure on national governments to control spending and borrowing. This inflation-fighting stance, keeping interest rates high enough for profitable investment, was exemplified by the first president of the ECB (1998 – 9.7.2003), Wim Duisenberg, with his words “I hear, but I don’t listen.”4 A test of resolve: European sovereign debt During the sovereign debt crisis, indirectly triggered by the collapse of Iceland’s banking system in 2008, European national governments with structurally high debts and public deficits were penalized by rapidly rising interest rates on new sovereign debt, as investors demanded increasing risk premiums. Only bail-out payments from the ECB and the IMF coupled with strong austerity measures to cut public spending prevented sovereign defaults. Fabrini observed “if the euro was adopted in the first place for preserving a European Germany, the euro crisis has brought the opposite effect, that is, the emergence of a German Europe. […] Politics has been substituted by macro-economic and judicial rules, whose respect is supervised by technocratic bodies unaccountable, directly or indirectly, to European voters.” 5 This is no discredit to an independent central banker, indeed it is a vote of confidence and trust.

A vote by Greek citizens in 2015 against further austerity measures coupled with social unrest raised the spectre of Greece having to exit the common currency. A year later, Britain – though never part of the euro – did vote to leave the EU, completing “Brexit” on 31st Jan 2020. In 2017, a collapse of the Italian banking system due to junk loans was narrowly averted. In response to these challenges, the ECB repeatedly instigated multi-billion-euro rescue programs of bond and asset purchases, coupled with an ultra-lose monetary policy and negative central bank interest rates from 2014 to stimulate lending and investment.

In the wake of the Covid-19 pandemic, the ECB significantly expanded debt purchases by a further 750 billion euro, of which 390 billion euro take the form of non-repayable grants, not loans. Much of the money is earmarked for huge government-run infrastructure development schemes notorious in the past for their inefficiency, cost overruns and under-delivery. It is questionable when, indeed if and - if not - in what form sovereign debts will be repaid to the ECB and the citizens of Europe.

3

ISSING, Otmar: “One size fits all! A single monetary policy for the euro area”, Frankfurt a. M., 20 May 2005.

DUISENBERG, Willem F. and NOYER, Christian: Press conference, with Q&A , Frankfurt a. M., 11 Apr 2001.

5 FABBRINI, Sergio: „After the euro crisis: A new paradigm for the integration of Europe”, Oslo, 18 Mar 2014.

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A change in the German relationship Any weakness in the ECB’s resolve to enforce fiscal responsibility on member states to fight real inflation in a non-political, non-ideological manner signals trouble. It means nothing less than abandoning the successful formula espoused by Tabellini: “EU policymakers (the ECB, the Commission, the majority in the Council) generally have a narrowly defined ‘mission’: price stability, enforcing the single market, holding the prices of agricultural commodities stable. […] Since EU policymakers have a narrow mandate and their decisions are often inspired by external technical criteria, they can be held accountable for their behaviour despite the absence of elections.”6 Should, however, a weak ECB court politics and populism with lose fiscal policy, the door is open for national governments to abdicate responsibility for reckless spending, with long-term detrimental budgetary consequences. Effectively, this triggers a reversal in “actor expectations and loyalty towards the new regional centre”7 with decision making passing back to local actors with their national loyalties. Unspoken chauvinistic attitudes may resurface even in a German finance ministry, such as: “the ECB is not run by Germans, runaway inflation is not our remit and not our fault, and anyway, the Southern Europeans have been raking up debts for years and will force communalisation of sovereign debts, so why not we now freely make debts too, instead of just paying for others”. It would be a dangerous rush to the bottom.

In my opinion, such psychological effects pose a systemic inflationary risk that cannot be ignored, particularly in an election year where the German finance minister is the party-political candidate of the Socialist Democratic Party (SPD) for next chancellor. There is always the political temptation to prioritize the short-term feel-good, not be a party-pooper, if one can later blame others, like the ECB, for not having enforced the necessary discipline.

Covid-19 is different: How a weak ECB and our politicians are failing us.

This summer, consumers across Europe are quickly returning to old ways – live entertainment, gastronomy, hotels, tourism, and travel. The effects of Covid-19 on these sectors were always going to be largely transient. Fundamental trends, such as increasing globalization, e-commerce, remote working and home delivery, may have received a boost through the pandemic, but proceed regardless. The transitional pain for the economy and the labour market is inevitable and hardly “free”. Nonetheless, the public bill to sustain the tertiary sector through the pandemic has not been paid but converted to mutual taxpayer debt, in each country.

Moreover, during the Covid-19 crisis, governments “invested” huge sums of public taxpayer money into subsidising national champions for a quick post-pandemic return to cheap air travel, package holidays and the car economy. Prima facie this was done to maintain salaries and jobs, but with the side-effect that traders and investors – who would normally be expected to shoulder downside risks themselves – were let off the hook and handsomely rewarded. As of course were the peddlers of all kinds of financial instruments, in the form of lucrative commissions.

6

TABELLINI, Guido: “Principles of policymaking in the EU: an economic perspective”, CESifo Economic Studies, Munich, vol 49, no. 1 (Mar 2003), p. 19.

7 SCHMITTER, Philippine C.: “Three Neo-Functional Hypotheses about International Integration”, International Organization, vol. 23, no. 1 (winter 1969), p. 166.

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National taxmen have averted their eyes to the large asset price and stock market windfalls in the form of soaring valuations for the privileged and moneyed few, whereas high-street banks - unincumbered by politicians - pass on the negative interest rate policy of the ECB to the average saver as zero to negative interest rates in the guise of bank service fees. Denied the right to withdraw full funds in cash due to capital controls, citizens are ushered into electronic forms of payment with full (tax) verification at time of transaction. This raises questions of privacy, choice and free will. At the same time, the ECB has shown itself inept at recognising the inflationary effect of legally convertible, but unlicensed crypto-currencies and non-fungible assets - invitations for money laundering, Ponzi schemes and other nefarious activities.

Conclusion Tone deafness at the ECB to overheating stock, real estate and virtual currency markets and the public spending bonanza of the German finance ministry are pumping up a financial bubble whose inevitable bursting risks plunging the EU into a structural debt trap and inflationary spiral. Rapidly rising material and commodity prices, including energy-transition premiums, are resulting in declining real incomes. Wages are not keeping pace. The Corona debts will likely be repaid by today’s young idealistic Europeans - from their potential inheritances and estate. In future, they will have even less means to generate new and further economic growth since the population structure is relentlessly ageing and reaching the limits of consumption.

As history has shown, the long-term effect of lots of cheap money will be an increase in social injustice and wealth concentration while, at the same time, the urgent environmental challenge will have been missed: responsibly reigning in surplus industrial production and per-capita consumption for the sake of the planet now. We should be expending less energy and capital today, not more tomorrow. At worst, the ECB’s mindless pressing forth on the inflationary growth track could cause the breakdown of the social market economy (“soziale Marktwirtschaft”) that has been the bedrock of the Germany’s wealth and social stability since 1949, with further unforeseeable consequences.

This author argues for an urgent return at the ECB and at the German finance ministry to prudent fiscal management principles and wealth stewardship even at the expense of higher (bank) interest rates and more measured capital investment programs. Over the coming years, postBrexit Britain will be the reference against which the EU and the euro will be gauged in a holistic, societal sense. Time will tell whether the tighter fiscal policy of the Bank of England (and the Federal Reserve, until recently) supported by an internationally competitive financial sector and independent legal system relative to a disorientated centralized supra-national ECB and a bankrupt European banking sector, could give the Europeans a run for their money. The ECB may yet regret not reading the signs and raising interest rates in a timely manner, having abandoned the ideal of fiscal prudence and given in to politics and the markets under the pretext of Covid-19. Let us not forget that finance is global, that Europe’s currency defences cannot match those of the United States, and that ultimately creditors claim their prizes. [end]